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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA CA PROFESSIONAL (STRATEGIC LEVEL II) EXAMINATION JUNE 2013 23404 - ADVANCED AUDIT & ASSURANCE
Instructions to candidates: (1) Time allowed: Reading and planning Writing (2) (3) (4) (5) (6) Marks : 100 marks Answer all questions. Begin each answer on a separate page. Submit all workings. All answers should be in English Language, in the answer booklets provided. The examination will be conducted as an open book examination and the following publications of CA Sri Lanka only will be permitted to be used at the examination hall. Sri Lanka Auditing Standards & Sri Lanka Standard on Quality Control 1 - 2011 Code of Ethics Sri Lanka Other Audit Pronouncements - (Sri Lanka Auditing Practice Statement, Sri Lanka Standards on Assurance Engagement, Sri Lanka Standards on Review Engagement, Sri Lanka Standards on Related Services) Sri Lanka Accounting Standards - 2011 Open Book Referential - Student edition (Code of Best Practice on Corporate Governance, Sri Lanka Accounting Standards - changes with effect from 1/1/2012, IFRICs and SICs applicable for financial period beginning on or after 1/1/2012) : 15 minutes : 3 hours

(7)

Students are allowed to bring permitted publications which are highlighted, sidelined or underlined. Short notes written on the permitted publications will also be allowed. Page tabs may be used to refer the pages. Notes, texts books (other than permitted publications) or any other materials will not be allowed. Photocopies/extracts of the above publications will not be allowed. Answers written on the answer booklets, graph papers and any other stationery, distributed at the examination hall, only are considered in marking of answer scripts. Any other attached documents are not taken into account at the time of marking answer scripts.

(8) (9)

Question No. 01 You are the manager in charge of the audit of Rajesh Hotel PLC. Rajesh Hotel PLC (RHP or Company) is a five star hotel located in the northern part of the country. It was established many decades ago by the grandfather of the current owner. It has 350 rooms and 5 suites and caters for tourists mainly from South Asia. RHP employs more than 500 employees. RHP is not liable to income tax. The financial statements of the Company have been prepared in accordance with Sri Lanka Accounting Standards comprising SLFRS and LKAS (hereafter "SLFRS"), as issued by the Institute of Chartered Accountants of Sri Lanka. For all periods up to and including the year ended 31 March 2012, the Company prepared its financial statements in accordance with SLASs effective up to 31 March 2011. The following extracts have been given from the financial statements for the year ended 31 March 2013 which Company has prepared in accordance with SLFRS effective for the periods beginning on or after 01 January 2012. First-time Adoption of SLFRS: The effect of Companys transition to SLFRS, is summarised in this note as follows: A. At the transition date, the Company chose to state the buildings that were at their fair value as deemed cost; as a part of the transition the Company also reviewed the useful life of each significant component of buildings. In addition, with effect from 1 April 2012, the Company reviewed the useful lives of each significant component of buildings. In the review process, the Company has taken into account the experience of recent refurbishment. Accordingly, depreciation was calculated for the year ended 31 March 2013 for each individual significant component of buildings. B. C. D. Leasehold property under previous SLAS was measured at revalued amounts. Based on SLFRS, this item is now reflected as Prepaid Lease Rent as at historical cost. Certain intangibles recognized based on previous SLAS, were revisited under SLFRS. Such intangibles that did not qualify to be recognized under SLFRS, were written off. Investment in shares in an entity that was earlier reflected as Investments at Cost under previous SLAS was shown as Other Non-current Financial Assets Available for-Sale, at fair value. For the year ended 31 March 2011, the measurement of this investment at fair value resulted in a fair value loss of Rs. 10 million through Other Comprehensive Income. The fair value loss was further increased by Rs 0.1 million for the year ended 31 March 2013. Apart from the above, the Company also reclassified Treasury Bills and Short Term Investments as Held to Maturity- Other Current Financial Assets. Creditors were measured at present value. (2)

E.

F.

Reconciliation of Equity as at 1 April 2011 (Date of Transition to SLFRS) Effect of SLFRS Adoption ReRemeasure classification ment (11) 11 (53) 53 (8) (2) (10) (20) (20) SLFRS as at 1 April 2011

Previous Classification

Notes

Previous SLASs

New Classification

Non-Current Assets Property, Plant and Equipment Leasehold Property Intangible Assets Investments

A B C D

536 12 2 11 561

Property, Plant and Equipment 4 Prepaid Lease Rent - Intangible Assets Other Non-current 1 Financial Assets. 541 536 100 Inventories Trade and Other 32 Receivables Cash & Short Term 5 Deposits Other Current 53 Financial Assets 190 731

Current Assets Inventories Trade and Other Receivables Investments Cash at Bank and in Hand

100 32 D 53 5 E 190 751

Total Assets Equity & Liabilities Capital and Reserves Stated Capital Reserves Retained Earnings Total Equity Non-Current Liabilities Employee Benefit Liability Current Liabilities Trade and Other Payables Total Liabilities Total Equity and Liabilities F

A,D A,F

230 307 81 618 5 5 128 128 133 751

(299) 299 -

(18) 1 (17) (3) (3) (3) (20)

230 Stated Capital (10) Reserves 381 Retained Earnings 601 5 5 125 125 130 731 Trade and Payables Other Post-Employment Benefit Liability

(3)

Based on the audit planning memorandum, the following matters have been noted by the audit team. Extract from Audit Planning Memorandum 1. As we have noted significant audit adjustments in the previous years audit arising due to cut off issues in sales and purchases, we decided to carry out more audit work focusing on this risk. Inventory count observation is a must as there are third party storages. The Company has remitted USD 1 million to a party for a future marketing arrangement, for which the Company has not obtained approval from the Exchange Control Department. It is the Company policy to outsource all activities from recruitment to payment of salaries in the HR function, to a payroll service provider. Under the current arrangement, the Company advances a lump sum amount at the end of the first week in a given month that is used by the payroll service provider to make payroll payments.

2. 3.

4.

Required: (a) Explain five (5) significant matters that you consider important, from the reconciliation of assets and liabilities as at the date of transition. Marks will only be awarded for significant matters. (10 marks) State two (2) specific audit focus for each of the matters identified in (a) above. (10 marks) Propose two (2) specific audit procedures to the audit team to carry out in connection with the cut off issue (as identified in item 1 of the Extract from Audit Planning Memorandum as given above). (3 marks) Propose two (2) specific audit procedures in observing the physical count of inventory, (as identified in item 2 of the Extract from Audit Planning Memorandum as given above). (3 marks) Explain the areas to be considered in evaluating the matters connected with the remittance of USD (as identified in item 3 of the Extract from Audit Planning Memorandum as given above). (3 marks) Propose two (2) specific audit approaches when auditing the outsourced payroll function, (as identified in item 4 of the Extract from Audit Planning Memorandum as given above). (3 marks) (Total 32 marks)

(b) (c)

(d)

(e)

(f)

(4)

Question No. 02 You are the manager in charge of the audit of Great Products PLC (GP), listed on the Colombo Stock Exchange. The following matters have surfaced during the audit that you are required to bring to the notice of the Partner through a written memorandum. Required: Evaluate each issue given in the following paragraphs. Your answer should include a discussion of the issue, conclusion or a suggested further action on each of the stated issue. (a) You noticed that GP has shown a balance under other asset termed as Advances against expenses of key management personnel. The CFO being a Chartered Accountant has mentioned to you to ignore the balances as that are not material and not provided any information about the nature of the balance. (4 marks) The audit team has completed tests of controls in the special cash receipts process. Based on the audit plan a sample of 25 dates was selected to test the controls based on a sampling method. In such sample testing, the team noted in four instances that there was lack of audit evidence whether the particular control has actually happened or not. (5 marks) GP carries out different CSR activities under various programs. During the year the company together with the employees carried out a large scale funds collection campaign in aid of the Cancer Hospital expansion. Many employees gathered round this activity with their friends and raised a considerable sum for this worthy cause. (4 marks) For the purposes of the audit, your team has identified inventory as a significant area. Inventory is located in five warehouses in different parts of the country. Four such warehouses are state-of-the-art logistics hubs with full IT enabled controls. One location is a third party owned warehouse. All five warehouses carry approximately equal value of inventories. You have called for a confirmation of inventory held by the third party, and received a satisfactory response with no differences between the ledger and the third party documentation. However your audit team has noted in the working papers, a immaterial difference between one Goods Issued Note submitted by the third party warehouse and GPs general ledger. The team has also noted a few comments made by the internal auditor of GP regarding the inventory items at the third party warehouse, where samples were verified by the internal auditor close to the year end. (5 marks) (Total 18 marks)

(b)

(c)

(d)

(5)

Question No. 03 You are the partner in charge of the audit of Macfree group of companies. The group is family owned. In order to grow the business, the board structure has been reconstituted recently with the appointment of executive directors and non - executive directors to the Board of Directors of the group. Further, professionals have been recruited to hold senior management positions, and they have been entrusted to make key business decisions and manage the operations of the group. At a recent discussion with the non-executive Chairman and the major shareholder of the group, you are informed that the directors and senior management are to be offered various incentives to retain and motivate them to grow the groups business. Along with attractive remuneration packages the group is to offer profit bonuses and an employee share option scheme to its senior managers. The Chairman is concerned over the confidentiality of remunerations and benefits and wanted to know what needs to be disclosed under existing accounting standards and regulations. Prepare a guideline to be issued to Macfree group of companies regarding the disclosures that are required to be made in relation to remuneration of key management personnel, according to the existing accounting standards and regulations. The report should refer to the accounting standards and regulations and provide guidance on the disclosure requirements contained therein. (15 marks) Question No. 04 Sennon (Pvt) Limited has been an external audit client of your firm for the last 2 years. The principal activity of the company is the provision of installation services for telecommunication companies. Thushari Silva has been the audit manager of this client for the last 2 years. While finalizing the audit of Sennon (Pvt) Limited for the year ended 31 March 2013 Thushari was fallen sick and you have been asked to replace her. You have not handled any work in relation to Sennon prior to this. Reviewing the audit file you gather the following information: The company had previously made losses and its brought forward retained earnings were a negative Rs. 23 million. The companys net profit after tax for the year ended 31 March 2013 amounts to Rs. 15 million. The company is involved in the installation of telecommunication towers and network equipment. All services carried out by company are based on contracts from telecommunication companies. The contract provides for the retention of 5% of the contract value, to be held for one year to cover any installation deficiencies. On review of correspondence, it was noted that Rs. 1 million of retention funds are not to be refunded due to installation deficiencies. The directors who are minority shareholders, are unwilling to amend the financial statements as the amendment will cause the earnings figure to drop below the level that has to be achieved for them to earn their performance incentives. (6)

Amounts due from related parties includes an amount of Rs. 5 million due from Sennon Development (Pvt) Limited (SDL). This amount has been advanced to SDL to pay for a survey and feasibility study of a property development project. The financial statements of SDL have not been prepared and audited for the last 2 years as the company has not been able to secure the land concerned, and SDL has not carried out any other transactions. A confirmation has been received from SDL for the balance as per their records which reflects a payable to Sennon (Pvt) Limited of Rs. 4.8 million. At the final discussion in concluding the audit, the directors of Sennon (Pvt) Limited offer you the position of head of finance of the group with an attractive remuneration package. They want you to join the company after completion of the current audit. Requirements (a) Based on the above review findings state whether you will modify the audit report. Explain giving reasons for your conclusions and outline the modification, if any. (10 marks) Comment on the conduct of the directors of Sennon (Pvt) Limited and explain why the integrity of the directors should be considered by your firm when deciding whether to continue to act as an external auditor for future periods. (10 marks) (Total 20 marks)

(b)

Question No. 05 You are a partner in Perera & Company. Your firm has been providing internal audit services to International Services (Pvt.) Ltd (ISL) for the last 2 years. In providing this service you have built up a professional relationship with the management of ISL. Your network firm, Perera Corporate Services (Pvt.) Limited (PCSL) is the company secretary of ISL. All work undertaken by PCSL is managed by Mrs. Silva, a Chartered Secretary. The statutory audit for the year ended 31 March 2013 is in progress and the directors of ISL have approached you to obtain an opinion from you regarding a disagreement they have with their current auditors. They have requested your written opinion so that it may be presented to their current auditors. Arising from this disagreement with the current auditors, the directors of ISL have also requested the following services from your firm: (i) (ii) that your firm be appointed the external auditor of ISL ;and that you, as the proposed engagement partner, attend the companys monthly board meetings.

Requirement Discuss the potential threats that will arise if you decide to provide the additional services requested by ISL and describe what safeguards (if any) could be put in place to mitigate those threats according to the Code of Ethics issued by the Institute of Chartered Accountants. (15 marks) (7)